Do You Know What Stocks You Own?

One of the benefits of investing in actively managed mutual funds is that you have a (hopefully!) highly trained professional managing your money. This person presumably has access to resources and information about the market that an individual investor on his or her own could never hope to have.

There's a lot of trust involved in giving your hard-earned money over to someone else to manage, so investors need to be confident that their dollars are being invested in the manner they expected. But digging deeper into fund holdings shows that this isn't always the case.

Taking libertiesA recent Wall Street Journal article highlighted the fact that a fair number of mutual funds have been inflicted with Apple fever -- even those whose mandates would seem to exclude owning the red-hot tech stock. According to Morningstar data, at least 50 small- and mid-cap funds own Apple (NAS: AAPL) , even though the stock is now the world's largest company based on market value. In addition, roughly 40 dividend-focused funds also hold Apple, even though Apple has never paid a dividend. Apparently, the stock is proving too tantalizing for some fund managers to pass up, even if it falls outside of their stated mandate.

Of course, this kind of crossover isn't limited to trendy, of-the-moment stocks. Many small-cap funds own a fair number of mid-cap and even some large-cap names. For example, Longleaf Partners Small-Cap (LLSCX), which employs a fairly concentrated investing approach and owns less than two dozen names, currently has a 7% allocation to large-cap stocks, 50% exposure to mid caps, and only 43% of equity assets in actual small-cap names, according to Morningstar definitions. The fund owns Level 3 Communications (NAS: LVLT) , which recently completed its acquisition of Global Crossing, even though it falls outside of standard small-cap definitions with a market cap of $5.4 billion. However, management still likes the stock because it feels that the combined value of Level 3 and Global Crossing is roughly three times higher than the stock's current price.

Likewise, it's not uncommon for domestic stock funds to reach out and grab some opportunities overseas. Fidelity Low-Priced Stock (FLPSX), for example, is primarily focused on domestic small- and mid-cap companies, but at last glance held nearly one-third of its assets in foreign stocks. And a handful of mega-cap names have also made their way into the portfolio, including Microsoft (NAS: MSFT) , which meets the fund's criteria for low-priced stocks (trading at or below $35 a share) despite its huge size. Of course, given that this fund now holds an astonishing $35 billion in assets, it's not too surprising that management has made some small moves into other corners of the market to put that money to work.

Just go with the flowBut even given all of this wide-ranging latitude, I don't think it's completely fair to say that fund managers are widely ignoring their mandates and simply investing wherever they feel like it. Are there some managers out there who let their buy and sell decisions be guided by whichever way the investing winds are blowing? Sure. But the vast majority of managers do a good job of keeping their funds in line with expectations.

Now since we are talking about active managers, however, there will almost always be a few holdings that fall outside the fund's usual area of focus. But assuming the manager only moves in that direction because he or she sees better opportunities, is that a bad thing? In other words, if a domestic stock manager sees more attractively priced stocks overseas, are you being harmed by having a few more foreign companies in your portfolio?

The right answer for youI think the question comes down to this: What is more important to you as an investor? Would you rather have a fund that sticks strictly to its intended corner of the market even if there are more attractive opportunities elsewhere? Or would you rather own a fund with the flexibility to pick up a few names from outside its main area of focus if the manager sees bigger bargains elsewhere?

If you fall into the first camp and value adherence to a style box and a strict fit within your asset allocation above all else, you would probably be better served by avoiding actively managed funds and instead sticking to passive investments like index funds or exchange-traded funds. Here you only get exposure to the specified asset class, no matter what is happening to prices there or elsewhere in the market -- there is no subjective manager's judgment. So instead of choosing Longleaf Partners Small-Cap, you might want to look at the Vanguard Small-Cap ETF (NYS: VB) . And instead of Fidelity Low-Priced Stock, the Schwab U.S. Mid-Cap ETF (NYS: SCHM) may be more your style.

But if you value having a more flexible approach and want to give your manager just a little bit of room to go where the opportunities are, an active fund is probably a better bet. Of course, you still want a fund that devotes the majority of its holdings to its stated objective (e.g., value stocks, foreign stocks, or small-cap stocks), but having a little bit of leeway isn't the worst thing in the world, assuming you can live with that flexibility in your portfolio.

In the end, it's important to know how the funds you own operate and how wide-ranging they are allowed to be, and whether or not they have used that leeway in the past. Owning the right investments for your temperament and long-term goals is one of the most important steps in the investing equation, so make sure you get this right -- right now.

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At the time this
article was published Amanda Kishis the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. The Motley Fool owns shares of Apple and Microsoft.Motley Fool newsletter serviceshave recommended buying shares of and creating bull call spread positions on Apple and Microsoft. Tryany of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.